Doug Irwin on Market Monetarism and the fed

Our friend Douglas Irwin professor of economics at Dartmouth College has an excellent new comment on on Market Monetarism and Federal Reserve’s latest actions.

Here is Doug:

“The Federal Reserve’s policy of large-scale bond purchases may have cheered global equity markets but economists have been more sceptical. These sceptics include Keynesians and inflation hawks, who either believe that monetary policy has been too easy since the crisis began or that it is impotent at the zero lower bound.

“Market monetarists”, however, hold that both these views are wrong. Market monetarism, a relatively new school, draws upon Milton Friedman’s monetarism of the 1970s and has become increasingly influential in policy circles.”

Doug continues:

“Most economists equate monetary policy with interest rates and conclude that monetary policy is easy because interest rates are low. Throughout his career, Friedman argued that this was fallacious.

…In Friedman’s view, the best way to judge the stance of monetary policy is by the growth of the money supply – which central banks have ignored since the early 1980s because financial innovation was believed to have destroyed the relationship between monetary aggregates and prices and nominal income. It is true that the standard monetary aggregates, which arbitrarily give equal weight to different components of the money supply, are flawed. But Divisia monetary indices, which weight the different components by the monetary services they provide, track prices and income much better.

…The Divisia M3 and M4 figures for the US money supply, calculated by the Center for Financial Stability, show that the money supply is no higher today than in early 2008. For all the fretting about the Fed’s accommodative policy, the money supply has barely increased and is way off its previous trend. This represents a very tight policy compared to Friedman’s rule that growth in the money supply should be limited to a constant percentage. The lack of growth in the money supply is an important reason why US inflation and inflationary expectations remain under control. The Federal Reserve Bank of Cleveland’s latest market-based estimate of the 10-year expected inflation rate is 1.32 per cent.”

So true, so true – US monetary policy remains fairly tight and there is little inflation risk in the near to medium term.

Back to Doug:

“Aside from financial markets, market monetarists have been among the few to applaud the Federal Reserve’s Ben Bernanke for extending quantitative easing (while questioning some policy details, such as paying banks interest on their excess reserves). Though his monetarist doctrine is most often remembered in the context of the high inflation of the 1970s, Friedman also recognised periods when monetary policy was too tight – including in the US in the early 1990s. Then, when inflation was under control but unemployment high because of a sluggish recovery, he wrote: “It is hard to escape the conclusion that the restrictive monetary policy of the Fed deserves much of the blame for the slow, and interrupted, recovery from the 1990 recession.””

Doug is one of the world’s foremost experts on economic and monetary history and an excellent and open-minded scholar. I am happy that he is has written this piece for the FT and can only hope that he will one day take up blogging as well.

PS the headline on Doug’s piece is somewhat misleading: “Why modern monetarists are sceptical about QE3”. I know for a fact that that is not the headline Doug put on his piece – sometimes editors makes odd mistakes.


Leave a comment


  1. Bill Marder

     /  October 16, 2012

    What do you think about the Divisia indexes? Who publishes them? Do you think we should pay more attention to them?

  2. But could Doug Irwin explain a failure of QE to expand Divisia money if IOR had not been paid? He is taking an old monetarist approach, in terms of which Fed staffers feel justified in their actions. He also leaves himself open to the charge of reflating bubbles. I don’t think he would convince John Taylor. (Then again I don’t think anyone would convince John Taylor.)

  1. Doug Irwin has a good take on market monetarism | Historinhas

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